Regular followers of IFRS Standards will note that there are no significant new standards looming on the horizon, as confirmed by board members of the International Accounting Standards Board (IASB) at PwC’s recent Meet the Experts conference.
With no specific new IFRS Standards to consider, the conference discussed some of the financial reporting issues that have arisen in the year. A key focus of the conference was climate change and reporting, following the creation of the new International Sustainability Standards Board. Alongside this, one of the most interesting discussions centred around impairment.
Under IAS 36, Impairment of Assets, an asset is impaired if the carrying amount (the figure in the balance sheet) exceeds the recoverable amount. The recoverable amount is the maximum value that an entity can receive from the asset, being the higher of the fair value less costs to sell and the value in use. (See also my short AB video on the subject.)
This article will look at some of the problems and issues that are currently being experienced in relation to the value-in-use calculation, which considers the cashflows expected from an asset. As it can be difficult to assess the cashflows to be generated from an individual asset, entities often do this based on examining a cash-generating unit (CGU), looking at groups of assets such as divisions or subsidiaries.
The issue of a time lag, with impairment being recognised ‘too little, too late’, remains a point of contention
The very nature of impairment being an estimate means that companies will not always be able to get it right, but representatives from the Financial Reporting Council and European Securities and Markets Authority noted that it was an area where they had seen problems this year.
Olaf Pusch, director of Accounting Consulting Services at PwC, listed some common problems and inconsistencies in the calculation of the value in use, particularly in relation to CGUs. The estimates used in this calculation can be quite technical, but some of the key high-level problems noted were:
- the basis of the calculation – some entities are not using formally approved budgets for these
- optimistic forecasts – some entities produce calculations based on approved budgets that were historically over-optimistic and inaccurate
- restoration and dilapidation provisions – entities sometimes incorrectly exclude these in the cashflow calculation, saying they are not core to a CGU.
The IASB is unlikely to develop rules for climate change but the calculations for impairment must be consistent with other areas
Possible IASB responses
Following the feedback received by the IASB on both the goodwill and impairment and agenda consultation projects, there remains a feeling that there are problems with the entity’s accounting for impairment. The issue of a time lag, with impairment being recognised ‘too little, too late’, remains a regular point of contention.
However, as part of the goodwill and impairment project, the IASB has already stated that it had found that the impairment calculation could not be improved in a cost-effective manner. While the impairment calculation is not going to be changed, IASB technical staff member Patrina Buchanan did acknowledge that the board would be discussing whether it could adjust IAS 36 in the future to improve the consistency in how companies use cashflow projections. This could relate to some specific guidance, which could be aimed at reducing some of the issues noted above.
Another key element that is likely to have a significant impact on impairment calculations is climate change. The new chair of the IASB, Andreas Barckow, stated that the board was unlikely to develop specific rules for climate change in the IFRS Standards (read the AB interview), but it was noted that the calculations required for impairment must be consistent with other areas. The assumptions used should not be inconsistent with those used in narrative reporting, and they also need to consider the impact of any new legislation or firm-specific policies.
While the estimation of climate risk is difficult, preparers have dealt with difficult estimates for many years
Mark O’Sullivan, director of corporate reporting at PwC, noted that while a majority of entities were discussing commitments relating to climate change, only a small number covered these in the reporting of their financial results. A criticism of corporate reporting can sometimes be that the narrative disclosures don’t always match the financial statements, and the impairment section is a place where this needs to be brought together.
While the estimation of climate risk is difficult, preparers have dealt with difficult estimates for many years. A key place for this to be dealt with is in the calculations relating to impairment. Companies may still not be able to provide for climate risk under IAS 37, Provisions, Contingent Liabilities and Contingent Assets, but they should include these in their impairment calculations.
Entities with stated commitments should be considering the future costs in meeting those obligations in their future cashflows, either through capital expenditure, increased repairs and maintenance or potential changes in energy prices. In addition to this, entities will need to consider if the useful lives of existing assets need to be reduced.
Impairments to go up?
While there may not be a new standard due on impairment, this certainly doesn’t mean that this isn’t a problem in financial reporting. The increased focus on sustainability and the upcoming sustainability standards are likely to result in an increased focus on the estimates made by management.
A natural result of that is that entities will surely be required to prepare new estimates, particularly in relation to costs. As a result, it may well be that more impairments are identified, and we could actually see a higher level of impairments in the near future than we saw during the pandemic.